This is in response to your request for an advisory
opinion on behalf of Vanguard Fiduciary Trust Company (Vanguard) concerning
the application of section 408(b)(8) of the Employee Retirement Income
Security Act of 1974, as amended (ERISA), and the parallel provisions under
section 4975(d)(8) of the Internal Revenue Code of 1986, as amended (the
Code),(1) to an in-kind investment in a
bank collective investment fund, as made under the circumstances described
herein.

Background

You represent that Vanguard is a trust company, based in
Valley Forge, Pennsylvania, that is organized under the laws applicable to
such entities under the Pennsylvania Banking Code. Vanguard is supervised by
the Pennsylvania Department of Banking. Vanguard is a wholly-owned
subsidiary of The Vanguard Group, Inc. (Vanguard Group).

The Vanguard Group manages assets through registered
open-end investment companies, pursuant to the Investment Company Act of
1940 (i.e., mutual funds). Vanguard manages assets held in collective trust
funds for employee benefit plans covered by ERISA. You state that many
Vanguard Group mutual funds and Vanguard trust funds serve as investment
options for participant-directed individual account plans, organized to
comply with section 401(k) of the Code (“401(k) plans”), and as
investments for other qualified retirement plans.

Vanguard structures stable value investment options,
designed to allow investors to receive current interest income and preserve
principal amounts, for many 401(k) plans either using a commingled trust, or
as a separately managed account for a particular plan. You state that over
900 plans use the commingled trust structure, and approximately 40 are using
the stable value separate account structure (referred to collectively herein
as “stable value portfolios”).

The commingled trust structure uses a collective
investment vehicle, the VRST Master Trust. Plans do not hold interests
directly in the VRST Master Trust, but instead invest in one of seven “feeder”
trusts – the Retirement Savings Trusts – that invest all of their assets
in the VRST Master Trust. Investment management fees are imposed at the “feeder”
trust level.

The commingled trusts used by Vanguard take the form of
collective investment funds intended to qualify as group trusts, pursuant to
Revenue Ruling 81-100, 1981-1 C.B. 326, and Revenue Ruling 2004-67, 2004-28
I.R.B., that are tax exempt under section 401 and 501(a) of the Code.
Vanguard serves as trustee for such commingled trusts.

Plans pay fees to Vanguard only at the level of the
stable value investment portfolio in which the plan directly invests. This
is the level of the separately managed account or, with respect to the VRST
Master Trust, the “feeder” trust level.

Vanguard’s stable value portfolios (i.e., the
commingled trusts or the separately managed accounts) currently invest in,
among other things, a series of fixed-income commingled trusts, the Vanguard
Targeted Return Trusts (the TRTs). The TRTs were established quarterly on a
rolling basis, each with a 5-year term, and managed to a constantly
decreasing duration to provide liquidity at the end of the 5-year term. At
any one time, there would be 20 TRTs in existence with durations ranging
from one quarter of a year to 5 years. Each quarter, one TRT would expire
and a new one would be created. The stable value portfolios managed by
Vanguard, including the VRST Master Trust, have invested in the various TRTs
based on their available cash, other investments and liquidity needs. The
VRST Master Trust holds the majority of the assets of each TRT.

You state that Vanguard created the TRTs as stable value
portfolios with high-quality fixed income securities with fixed maturity
dates. These securities were then backed by “wrap” contracts with
insurance companies or banks to provide for certain disbursements to be made
at the “book” value of the assets, rather than the market value. This
structure is commonly referred to as a “synthetic” guaranteed investment
contract arrangement.

You represent that for various reasons related to
investment management strategies and cost efficiencies, Vanguard has begun
to phase out the TRT program. As the existing TRTs mature, they are being
replaced by investments in two commingled trusts of comparable aggregate
duration – the Vanguard Intermediate-Term Bond Trust (ITBT), and the
Vanguard Short-Term Bond Trust (STBT). These trusts (collectively, the Bond
Trusts), like the TRTs, invest principally in high-quality fixed-income
securities.

As a means of transitioning to the new investment
management structure, and more quickly realizing the efficiencies and other
benefits of managing assets through the Bond Trusts rather than the existing
TRTs, Vanguard would like to transfer the assets of the TRTs in-kind to the
Bond Trusts as soon as possible, and then terminate the TRTs.

Specifically, TRT securities would be allocated to the
Bond Trusts based on the TRTs’ average durations. Each TRT would receive
in return interests in the applicable Bond Trust – i.e., the STBT or ITBT
– that are equal in value to the value of the securities it transferred to
the respective Bond Trust. The same business day, the TRT would distribute
those Bond Trust interests to each stable value portfolio that holds
interests in the TRT, in proportion to the portfolio’s TRT interests, and
then terminate. At the end of the business day, each stable value portfolio
would hold Bond Trust interests equal in value to its former TRT interests.

The principal advantage of liquidating the TRTs through
in-kind exchanges of securities for interests in the Bond Trusts, as opposed
to liquidations for cash on the open market, would be to avoid transaction
costs. The total transaction cost estimates are in the range of $5.4 million
as existing TRTs have securities with an estimated market value of
approximately $3.4 billion. In addition, Vanguard seeks to avoid the
possibility of the Bond Trusts not acquiring the same securities on the open
market that are sold by the TRTs.

You represent that the trust documents for the TRTs and
the Bond Trusts provide the necessary authority for Vanguard to cause the
TRTs to make an in-kind investment in the Bond Trusts. You state that the
TRTs, by their terms, permit investment in a collective investment fund
maintained by the trustee of the TRTs (i.e., Vanguard), where the fund
invests principally in securities of the type in which the TRT is permitted
to invest. Specifically, Article 6.1(a) of each TRT gives the trustee the
authority, in its sole discretion, “to invest and reinvest the Trust in
such investments and other property, without restrictions to investments
authorized for fiduciaries, as the Trustee determines in accordance with the
Trust’s investment objective as set forth in Article 1.2 …, including,
without limitation, (i) any other collective investment trust maintained by
the Trustee…”

Your represent further that the trust documents for the
Bond Trusts permit investment by any common, collective or commingled trust
fund or group trust that consists solely of the assets of pension,
profit-sharing and other qualified plans, and/or other types of retirement
plans or vehicles holding retirement plan assets. Under Article 1.02 of the
STBT and Article 2.2 of the ITBT, an investment in units of the respective
Trust may be made in the form of cash, or in the form of other property
acceptable to the trustee.

For purposes of the in-kind investments by the TRTs in
the Bond Trusts, you state that the assets being transferred would be valued
in a consistent manner by both the investing and receiving trusts, using
independent pricing sources.

Specifically, for valuing fixed-income securities,
Vanguard uses the same pricing services for both the TRTs and the Bond
Trusts. Where none of the pricing services used makes a value available for
a particular security, or where there has been a significant change in value
of the security from the previous price used (i.e., greater than 1%),
Vanguard will obtain quotations from three (3) different independent
brokers, and will use the lowest of the three available quotes. You state
that pricing services and broker quotations are not used for short-term
instruments maturing within 60 days. Thus, pursuant to the trust document’s
valuation provisions, these instruments would be valued at cost (plus or
minus any amortized discount or premium). All valuations would be made as of
3:00 p.m. Eastern Time on the valuation date.

Vanguard serves as trustee of both the TRTs and the Bond
Trusts – all of which, as bank collective investment funds, are deemed to
hold “plan assets” subject to ERISA pursuant to the Department’s
regulations (see 29 CFR §2510.3-101(h)(1)(ii)). For this reason, you state
that Vanguard would find itself acting in a discretionary role on both sides
of any transaction between the TRTs and the Bond Trusts. Thus, the in-kind
investment by the TRTs in the Bond Trusts could be viewed as a sale by the
TRTs of their securities to the Bond Trusts, with Vanguard, in its capacity
as trustee, acting in the role of both the buyer and the seller.

Advisory Opinion Requested

You request an opinion as to whether a purchase of
interests in a collective investment fund through an in-kind investment of
securities would be exempt from the prohibited transaction provisions of
section 406 of ERISA by reason of the statutory exemption contained in
section 408(b)(8) of ERISA.

Relevant Provisions of ERISA and Analysis

Section 406(a)(1) of ERISA provides, in part, that a
fiduciary with respect to a plan shall not cause the plan to engage in
certain direct or indirect transactions with a party in interest, including
sales or exchanges of property between the plan and a party in interest
(section 406(a)(1)(A)), and transfers to or use by or for the benefit of a
party in interest of any assets of the plan (section 406(a)(1)(D)).

Section 406(b)(1) of ERISA prohibits a fiduciary with
respect to a plan from dealing with the assets of the plan in his or her own
interest or for his or her own account. Section 406(b)(2) of ERISA provides
that a fiduciary shall not in his or her individual or in any other capacity
act in any transaction involving the plan on behalf of a party (or represent
a party) whose interests are adverse to the interests of the plan or the
interests of its participants or beneficiaries.

Section 3(21) of ERISA defines a “fiduciary” of a
plan to include a person who exercises any discretionary authority or
control respecting management or disposition of its assets; or who renders
investment advice for a fee or other compensation, direct or indirect, with
respect to any moneys or other property of the plan, or has any authority or
responsibility to do so.

Section 3(14) of ERISA defines the term “party in
interest” to include a fiduciary and a person providing services to a
plan.

The Department’s regulation at 29 CFR §2510.3-101
defines what are considered to be “plan assets” when a plan invests in
another entity. The regulation provides, at 29 CFR §2510.3-101(h)(1)(ii),
that when a plan acquires an interest in a common or collective trust fund
of a bank, its assets include its investment as well as an undivided
interest in each of the fund’s underlying assets.

As you have acknowledged, Vanguard is a fiduciary under
section 3(21) of ERISA with respect to ERISA-covered plans for which it
serves as trustee. Pursuant to the Department’s regulations defining “plan
assets” (as noted above), Vanguard is also a fiduciary for ERISA-covered
plans that invest in the TRTs, either through separately managed accounts or
commingled trusts, by reason of its discretionary authority and control over
such assets. You indicate that Vanguard receives investment management fees
from plans that invest in such accounts or trusts invested in the TRTs, at
either the separate account or “feeder” trust level, as applicable.

Therefore, unless an exemption applies, you are concerned
that Vanguard would violate sections 406(a)(1)(A), 406(a)(1)(D), 406(b)(1),
and 406(b)(2) of ERISA if, as a fiduciary of ERISA-covered plans, it caused
“plan assets” invested in the TRTs to be invested in the Bond Trusts.

Section 408(b)(8) of ERISA exempts, in pertinent part,
any transaction between a plan and a common or collective trust fund
maintained by a party in interest which is a bank or trust company
supervised by a state or federal agency, if the following conditions are
met:

the transaction is a sale or purchase
of an interest in the fund,

the bank or trust company receives not
more than reasonable compensation, and

such transaction is expressly
permitted by the instrument under which the plan is maintained, or by a
fiduciary (other than the bank or trust company or an affiliate) who has
authority to manage and control the assets of the plan.

You represent that the TRTs and Bond Trusts are
collective trust funds maintained by Vanguard, a trust company supervised by
the Pennsylvania Department of Banking. The transactions at issue would be
purchases of interests in the Bond Trusts, and would be authorized by the
applicable trust documents relating to each TRT and Bond Trust. Vanguard
would not be paid any separate fees by the Bond Trusts for the assets
invested therein by the TRTs. You state that Vanguard’s existing fee
arrangements with plans would remain unaffected by the proposed transactions
and it would not receive more than reasonable compensation as a result of
the transactions.

With respect to the conditions of ERISA section
408(b)(8), although the statutory provisions do not define the term “reasonable
compensation” for purposes of the exemption, the ERISA Conference
Committee Report (as issued by Congress in 1974) provides that:

“[t]o be allowed, no more than reasonable
compensation may be paid by the plan in the purchase (or sale) and no more
than reasonable compensation may be paid by the plan for investment
management by the pooled fund.”

[See H.R. Rep. No. 93-1280, 93rd Cong., 2nd Sess., at 316
(1974)]

Thus, Congress anticipated that the term “reasonable
compensation” would apply to the purchase or sale of an interest in a
collective investment fund by a plan and to amounts to be paid by the plan
for investment management of such assets.

In addition, with respect to covered transactions, the
ERISA Conference Committee Report does not appear to distinguish cash from
in-kind assets, nor does it specify a particular form of investment, with
regard to any purchase or sale of interests or units in a common or
collective investment trust fund, or pooled investment fund, maintained by a
party in interest which is a bank or trust company. Furthermore, at the end
of the relevant section discussing the provisions of ERISA section
408(b)(8), Congress expressed the view that, under the general fiduciary
rules of ERISA, a bank “…cannot use pooled funds as a place to dump
unwanted investments which were initially made on its own (or another’s
behalf).” Id.

In this regard, by noting the possibility of a bank
placing investments it previously had made into a collective investment
fund, Congress appears to have anticipated in-kind investments being made
into such a fund as a “purchase” covered by the statutory exemption.

Accordingly, it is the opinion of the Department that the
statutory exemption provided under section 408(b)(8) of ERISA would permit
an in-kind exchange of securities owned by a plan or fund holding “plan
assets” for units or interests in a collective investment fund maintained
by a bank or trust company, provided that the conditions necessary for
relief as stated therein are met.(2)
However, please note that the issue of whether all of the conditions
of section 408(b)(8) will be met is a factual determination upon which the
Department cannot opine. Therefore, the appropriate plan fiduciaries,
including Vanguard, must determine, based on the particular facts and
circumstances, whether the conditions of section 408(b)(8) will be met for
the proposed in-kind exchanges.

In particular, the Department notes that the exemption
provided in section 408(b)(8) is available for the proposed in-kind
exchanges only if the valuation method used by Vanguard in connection with
each transaction results in a plan paying no more than reasonable
compensation for its investment. In our view, a plan would pay more than
reasonable compensation in any in-kind exchange in which the value of assets
transferred to a fund would be more than the value of the fund units or
interests the plan received.

Therefore, the Department cautions Vanguard to ensure
that appropriate procedures and safeguards are in place to guarantee uniform
pricing of both the relevant “plan assets” in each TRT to be transferred
to each Bond Trust and the Bond Trust’s units to be received by each plan’s
stable value portfolio investment. As described herein, such investments
would include the Retirement Savings Trusts that are “feeder” trusts for
the VRST Master Trust, as managed by Vanguard on the date of the
transactions.

Finally, the Department is providing no opinion herein as
to Vanguard’s current or future stable value investment strategies, or
courses of action to implement to such strategies (including methods for
saving transaction costs or avoiding market impact).

Section 404(a)(1) of ERISA provides, in pertinent part,
that fiduciaries shall discharge their duties with respect to a plan with
the care, skill, prudence, and diligence under the circumstances then
prevailing that a prudent person acting in a like capacity and familiar with
such matters would use in the conduct of an enterprise of a like character
and with like aims. Among other things, a fiduciary must give appropriate
consideration to those facts and circumstances that, given the scope of such
fiduciary’s investment duties, the fiduciary knows or should know are
relevant to the particular investment or investment course of action
involved, including the role the investment or investment course of action
plays in that portion of the plan’s investment portfolio with respect to
which the fiduciary has investment duties.(3)

This letter constitutes an advisory opinion under ERISA
Procedure 76-1, 41 Fed. Reg. 36281 (1976). Accordingly, this letter is
issued subject to the provisions of that procedure, including section 10
thereof, relating to the effect of advisory opinions.

Under Reorganization Plan No. 4 of
1978, effective December 31, 1978 [5 USC App. at 214 (2000 ed.)], the
authority of the Secretary of the Treasury to issue interpretations
regarding section 4975 of the Code has been transferred, with certain
exceptions not here relevant, to the Secretary of Labor and the
Secretary of the Treasury is bound by interpretations of the Secretary
of Labor pursuant to such authority. Therefore, references in this
letter to specific sections of ERISA should be read to refer also to the
corresponding sections of the Code.

See Adv. Op. 96-15A (Aug. 7, 1996),
wherein the Department took the position that section 408(b)(8) of ERISA
provides relief from sections 406(a)(1)(A), 406(a)(1)(D), 406(b)(1) and
406(b)(2) for the purchase or sale by a bank or trust company, as
fiduciary of ERISA-covered plans, of interests in a collective fund so
long as the conditions of the statutory exemption are met, including
that the transaction be expressly permitted by the plan or an authorized
independent fiduciary.

The Department notes that regulation
§2550.404a-1 defines appropriate considerations for an investment
course of action by fiduciaries in such matters.